Stocks extend gains on Greece, DAX set for breakout

The European stock market bulls are not exactly showing the sort of optimism that they did on Monday, but are nonetheless still in buoyant mood. The German DAX index, for example, is ‘only’ up 1% compared to some 3.5 per cent it gained the previous session. The still-upbeat sentiment is driven first and foremost by hopes that a deal for Greece will be achieved at some point this week. After the Greek government blinked at the weekend, investors were hoping for a resolution as early as Monday. However, as it turned out, they delivered the economic reform proposals too late. The proposals also lacked sufficient detail and this made an agreement to unlock the €7.2 billion of aid impossible. However, the proposals were seen as a positive step that could form the basis for an agreement later this week. Without a deal, Greece could default on a €1.5bn repayment to the IMF at the end of June.

As well as Greece, sentiment has also been lifted by the latest Purchasing Managers’ Indices (PMIs) from the euro zone’s manufacturing and services sectors that were released this morning, which were all better than expected. The composite PMI hit a four-year high of 54.1 in May, climbing from a reading of 53.6 last month. The services sector PMI was 54.4 versus 53.8 previously, while the manufacturing PMI rose to 52.5 from 52.2. Crucially, the PMIs at the economic powerhouse that is Germany were also stronger than expected. It looks like the ECB’s on-going bond buying stimulus programme and a weaker euro and oil price are all having a positive impact on economic growth. The potential for further acceleration in economic growth in the Eurozone means we are bullish on the long term outlook for European stocks.

In the short term, the Greek situation is likely to determine the market direction. But as no agreement has been made yet, are investors getting too ahead of themselves? If the situation were to deteriorate, we could see some panic selling, especially by the speculators who have bought the stocks on the “cheap” this week. So, equities could easily go in reverse later in the week. Also, it is worth mentioning that some of the good news has now been priced in. Thus, if a deal for Greece was to be reached this week, this could give stocks another shot in the arm, but then the euphoria could quickly fade as some shrewd traders who had bought the rumours, go on to sell the news.

Technical outlook: DAX trying to break out of bear channel

Following the sharp rally at the start of this week, the DAX has now broken several resistance levels, which has further aided the rally as the shorts were forced to cover their positions. As well as the pivotal 11200 mark, the index has taken out the prior resistance at 11450; this level could now turn into support in the event of a near term pullback. As we had reported previously, the DAX had been declining inside a bearish channel for several weeks. Last week it created a reversal pattern at the lower end of this channel when it formed a large bullish engulfing candle on Thursday June 18. This particular candlestick formation correctly suggested that there was a shift from selling to buying and although there wasn’t much immediate follow-through on Friday, we have seen strong bullish momentum at the start of this week as just mentioned. The index is now trying to break outside of this bear channel, testing the upper resistance trend around 11590. Though it is likely we may see some profit-taking here following the sharp rally, a potential breakout could bring out fresh buyers and discourage the bearish speculators further. As a result, we could well see some further follow-up technical buying even if we don’t hear any fresh good news regarding Greece today.

If the abovementioned resistance level is taken out, then bulls may then aim for the 61.8% Fibonacci retracement level of the downswing from the all-time high of 12408 hit in April, at 11790/5, as their next target. Beyond this level is the May high at 11927 and if this level is taken out then a move all the way to, and potentially beyond, the prior record high of 12408/10 would be likely.

So, things are looking rosy for the German DAX index and European stock markets across the board. But the bulls do require the former to break out from its bearish channel before more gains could be seen. Obviously a deal for Greece could trigger a fresh bout of buying frenzy, though this could be short-lived as most of the good news is now priced in. Over the longer term outlook, the European stock markets are likely to remain supported by the virtually zero interest rate policy and the on-going bond buying stimulus programme at the ECB. Meanwhile, a particularly bad outcome for the stock markets would be if Greece fails to find a deal with its creditors this week. An even worse outcome would be if it defaults come the end of June and worse still would be if it eventually exited the euro zone.

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Source: FOREX.com. Please note, this product is not available to US clients

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